Tame NZ inflation may see Reserve Bank flag longer pause in raising rates

Monday 8th December 2014

The Reserve Bank of New Zealand, faced with inflation that has undershot its forecasts, may signal a longer pause in its tightening cycle this week and a lower peak when interest rates do rise.

Governor Graeme Wheeler will keep the official cash rate at 3.5 percent when he releases the monetary policy statement on Thursday, according to all 12 economists in a Reuters survey. He may signal a longer wait before raising interest rates via the bank's projected path for 90 day bank bills.

Wheeler made no reference to raising interest rates in his last review on Oct. 30, saying only that "a period of assessment remains appropriate before considering further policy adjustment." He had the benefit of third quarter consumer price index data in October that showed annual inflation had slowed more than expected to 1 percent, the bottom of the bank's target range and 30 basis points below its forecast. Since then the price of oil has fallen and dairy prices have declined.

"We think it will now take until late 2015 before the RBNZ gets that sign of a pick up in inflation pressures that will prompt it to move," said Nick Tuffley, chief economist at ASB. "We now expect the RBNZ will keep the OCR on hold until December 2015, with one further OCR increase beyond that for an OCR peak of 4 percent in March 2016."

Brent crude oil futures for January settlement fell to US$69.07 a barrel on the ICE Futures Europe exchange on Friday, the lowest in five years, bringing the slide this year to 38 percent. The Organisation of Petroleum Exporting Countries has maintained production targets at 30 million barrels a day even in the face of waning global demand.

"From an inflation perspective, lower oil prices will keep headline inflation down and dampen inflation expectations," Tuffley said. While the central bank looks through the direct impact on inflation from fuel, it will focus on "any second round effects, via changes in firms’ price setting behaviour and households’ inflation expectations."

Companies have wound back their inflation expectations, based on the Reserve Bank's survey of expectations released on Nov. 25. Firms see the consumers price index rising an annual 1.59 percent in the year ahead, down from the 1.96 percent pace they predicted three months ago. Two year inflation expectations fell to 2.06 percent from 2.23 percent.

Dominick Stephens, chief economist at Westpac Banking Corp, expects three key messages from Wheeler in the MPS, "inflation is currently very low, but is expected to rise eventually; the OCR is firmly on hold for now, but is expected to rise eventually; The exchange rate is too high."

"The hiking bias has been weakened but not eliminated," he said in a note. There is a risk confirmation the OCR will remain on hold for some time to drive down swap rates on the day of the MPS, while any jawboning about an overvalued dollar could see "a knee jerk drop in the exchange rate on the day."

The trade weighted index was last at 77.31, having dropped from as high as 82.03 in July. On this basis, the currency is below the average rate the central bank forecast for the final quarter of 2014 of 78.40. A weaker currency bumps up the cost of imported goods while reducing the value of overseas sales when they're brought home.

Dairy product prices sank to the lowest level since August 2009 in last week's GlobalDairyTrade auction and dairy also helped knock the nation's terms of trade down from a 40 year high in the third quarter. Economists expect Fonterra Cooperative Group to lower its milk payout forecast this month, from last season's record payout, reducing the stimulus to the broader economy.

"Although the economic outlook remains quite reasonable, even in the face of weak dairy prices, inflation itself remains missing in action." ASB's Tuffley said. "Weak oil prices reinforce that inflation will be weak in the near term."

BusinessDesk.co.nz

Comments from our readers

No comments yet